The Biggest Fire Sale in History

It’s going to be the biggest fire sale in history — and it begins in 2012.

Europe’s banking sector holds 2½ times as many assets as the U.S. banking sector. It’s huge. And it’s in big trouble. Europe’s banking sector needs cash — mountains of cash.

As a result, it will have to sell more than $1.8 trillion of assets, which will likely take a decade to work through. For perspective, it sold only $97 billion from 2003–10. “The list of asset sales is the longest I’ve seen in 10 years,” says Richard Thompson, a partner at PricewaterhouseCoopers in London. Knowing how these things work, the final tally could well be double that. The world has never seen anything this big before.

Where will the cash come from?

This is our opportunity. There is no better, more-reliable way to make money than to buy something from someone who has to sell. Bankers are the best people in the world to buy from. Believe me, I know.

I was a vice president of corporate banking for 10 years before I started writing newsletters in 2004. I would get at least three or four requests every year from some investor group asking if we had any assets we were looking to unload. Why? Because they know banks are stupid sellers.

I once had a big real estate deal go bad on me. But I knew I was covered by good collateral twice over. You’d never know it based on the pressure I got to get rid of the thing once the borrower stopped paying and the bank took the asset. I knew, given a little time, I could sell the property and make a bundle for the bank. But the folks at the top didn’t want to hear it. They wanted that bad loan gone. They wanted to wipe it off the books fast.

So I sold it quickly, basically at fire-sale prices. It was still the most-profitable loan the bank made that year, because I got a price a good 35% above the loan amount. But the group I sold it to — which could’ve been more patient in marketing the property – flipped it again and made an easy 50% above that. The bank left a lot of money on the table and knew it — and didn’t care.

But institutionally, banks can’t really hold bad debts for long. As soon as they report a big bad debt on a quarterly financial statement, some annoying things happen. It means they have to put aside more capital for this particular loan, which they hate to do, as it lowers profitability and requires a lot of paperwork. It can raise the attention of regulators, which banks hate. It can raise shareholder suspicions about lending practices, which banks hate. So the usual way to deal with bad debts is to clear ’em out as fast as possible. (Unless you’re swamped with bad debts in a full-blown crisis, in which case you try to bleed them out and buy time to earn your way out, and/or patch them up as best you can to keep up appearances while you pray for a miracle — or a bailout.)

With the EU banking sector loaded with trillions of stuff it must sell, the mouths of knowing investors drool with money lust. These are deals the big boys do. Prem Watsa, the brain behind Fairfax Financial and dubbed by some as “the Warren Buffett of Canada,” gets to do these deals. Wilbur Ross, the billionaire investor famous for investing in distressed assets, gets to do these deals. Warren Buffett he gets to do these kinds of deals.

Normally, you need a fat wallet to get in this club. But I recently found a way to get into this “club” that a public-school teacher could afford.

One such investor is a guy named Bill McMorrow. You’ve probably never heard his name before. But his current joint venture fund has returned 42% annually since it began in 1999 by buying up distressed property from banks.

McMorrow has a lot practice buying stuff from banks. In 1995, he bought up property debt from troubled Japanese banks. In 1997, he waded into Hawaii’s busted property market, picking up a 450-acre land parcel at Kohanaiki on the “Big Island.” In the U.S. financial crisis in 2008, he bought up apartment buildings in California. This is the sort of thing that builds 42% annual returns through the storms of crisis-filled markets.

His company and partners recently bought $1.8 billion of U.K. real estate from the troubled Bank of Ireland at a 20% discount to the face value of the loans.

“This is a very high-quality loan portfolio,” McMorrow said. “All the loans are current.”

There are 170 properties that secure these loans. All of the property is in the U.K., and 60% is in London. It’s a mix of office, multifamily and retail, with a smattering of industrial property, hotels and land. I’m betting he’ll make a mint.

McMorrow is a real estate guy through and through. It’s what he knows. He’s been at it for 36 years. So his opinion and track record ought to carry water. “When you look at the opportunities around the world,” McMorrow said, “we really feel over the next three–five years that the greatest opportunities — for all the reasons that everybody reads about now everyday — exist in Europe. The markets here in the United States, although there will always be some opportunities to buy things at prices that we like, have become, I would say, way more efficient. There is more capital and there is more efficiency in the market, so prices in many cases got bid up to the point where we’re probably not buyers.”

But in Europe, the banks have to raise cash. I think the EU crisis, as boring as it is, is about to get a lot more interesting as investors get a chance to pick up cheap assets from the biggest fire sale in the history of earth.

Chris Mayer is managing editor of the Mayer's 100x Club and Mayer's Special Situations newsletters. Graduating magna cum laude with a degree in finance and an MBA from the University of Maryland, he began his business career as a corporate banker. Mayer left the banking industry after ten years and signed on with Agora Financial. His book, Invest Like a Dealmaker, Secrets of a Former Banking Insider, documents his ability to analyze macro issues and micro investment opportunities to produce an exceptional long-term track record of winning ideas. In April 2012, Chris released his newest book World Right Side Up: Investing Across Six Continents.

These suckers have dragged down the entire market for months. It’s been a tale of two Dows. The Dow Jones Transportation Average has dropped more than 8% on the year. But the Dow Jones Industrial Average has just about broken even over the same period. That shows you just how bad the trannies have been.

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